Sunday, May 23, 2004

What Ails the Health Care Markets?

Many on the political right believe that the U.S. health care system should be operated as an unregulated market system, without government intervention. (If this sounds alien to you, replace the word 'unregulated' with the word 'free'. The term 'free markets' has gained such religious overtones among some pro-market groups that it no longer has a clear economic meaning. I prefer to call such markets unregulated.)

Totally unregulated markets in health care will not work for reasons that have to do with the basic characteristics of medical care. For simplicity, compare some medical care commodity, say, the provision of an appendectomy to that of some more ordinary consumption good, say, bread. Then consider the differences between the two commodities:

1. Feeling hungry is an adequate reason for a person to decide to buy bread. In contrast, all a patient who will end up having appendectomy knows is that something hurts a lot. Thus, we know our own needs when buying bread, but we are unsure about whether we even need an appendectomy. The level of information is very different in the two cases; in the latter case we as consumers lack most of the necessary information.

There are no such people as specialists who tell us when we should buy bread. But we do have exactly such specialists in health care, usually physicians, who diagnose and inform us about our condition and the best products and services to buy for it. This creates an unusual situation, as the person advising us about these needs is also in most cases the person who is going to sell us the products and services, and is therefore directly going to benefit from our purchases. Just think what would happen if bakers were allowed to decide how much bread we 'need'.

This dependency on professional advice leaves patients quite vulnerable. An unregulated health care market would not stop ruthless providers from exploiting the most desperate and/or wealthiest consumers. One reason why physicians traditionally did not advertize lies in this very fact: such advertizing can never be guaranteed to be objective, given the self-interests of providers and the lack of information most consumers possess.

2. Hunger is quite predictable, and if a person likes bread she or he can plan its purchases long in advance. Much of health care use is very unpredictable. With the exception of routine checkups and preventive care, health care consumption can't be planned in advance. Illness and accidents are uncertain events, and this fact makes health care use also an event which we can't predict with certainty. This is the basis for health care insurance. Insurance solves the problem of unpredictability and the need to keep large sums of money at hand for any major expenses. Instead, insured consumers can pay a fixed smaller sum every month (or have their employers pay it on their behalf).

While having insurance is a good thing, on the whole, insured patients behave differently from those who have no insurance. Just think what you would do if you had insurance for bread eating with no cash down needed. You would probably buy more expensive types of bread and more bread in general. This is what happens in health care markets, too. As a consequence, prices don't have their usual ability to affect consumer purchases. What most people take into account in their calculations is the actual amount of money needed (for example any deductibles and copayments), not the total bill of the treatment. Yet it is this total which is counted in the overall costs of medical care.

3. Quality assessment by patients is extremely difficult. In contrast, most of us can tell when bread is stale, and it usually takes just a small sample to find if we like the taste. Taking small samples of health care services may not be practical. It can even be extremely dangerous. That's one of the reasons why patients employ providers as advisers on the type and quantity of care needed. It's also the reason why pharmaceuticals and hospitals are so rigorously regulated, and why the system of malpractice suits exists.

Quality or effectiveness of health care is not completely known even to its providers. Many treatments are routinely carried out that might have only minor impact on the disease they aim to treat. New technologies are sometimes developed on the basis of nothing much more than a hunch, and they often spread widely before any research can be carried out about their appropriateness.

4. Whether I consume bread or not should have no direct impact on others' welfare (though it may affect others indirectly if I'm very poor and others would like me to have more bread). Whether I get treated for an infectious disease or not is of obvious direct interest to others: If I don't get treated, I am going to be a risk in the community. This means that the society as a whole, usually seen as reflected in the government, has an interest in assuring that infectious diseases and other general health problems are tackled. Markets tend to underprovide such services. Why? Because firms don't have the ability to charge other people for the benefits they receive when someone else's infectious disease is treated. These benefits are not then taken into account in market decisions; only the private demand of those infected will be satisfied by the market forces.

All these differences between bread and various types of medical care explain why markets perform poorly in health care and well in the bakery industry. Competitive behavior in most markets drives prices down, keeps quality up and offers variety to the consumers. But in health care prices may not go down with competition because consumers can't always judge what they are getting in quality, which makes per unit prices meaningless, and because insured patients are not taking the whole price into account in making decisions. Quality may not increase through competition if consumers are truly unable to judge quality, or if they use wrong signals to measure the inherently unknown quality. As an example, think about hospitals offering intricate technological services. Competition between hospitals might make them all acquire the latest gadgets, and consumers might think that a well equipped hospital is a high-quality one. But in reality, such competition may mean that none of the hospitals gets enough patients that actually need these services. The personnel operating the technology may not then get enough practice to remain skilled. And, as noted above, markets will underprovide those medical care services which have strong effects on the well-being of others than the patient under treatment.

For these reasons health care costs keep on rising year after year, despite our best attempts to control them, competition seems to have no real impact on keeping prices low, malpractice suits remain common and government regulation an important aspect of health care. The markets for bread, on the other hand, are doing pretty well with minimal intervention.

Those who advocate unregulated health care markets seem to assume that medical care is no different from bread, and that just getting rid of the government role in health care markets would make an appendectomy as affordable, bland and safe as sliced bread. I hope that this post shows why they are wrong.

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